Site Navigation

Site Mobile Navigation

China’s Water Pistol

China is the biggest buyer of Treasury bonds at a time when the United States has record budget deficits and needs China to keep buying those bonds to finance American debt.

As I said, this was a very good article about China; the debt line was probably inserted because it’s considered obligatory to say this in any article about US-China relations. As it happens, however, while it’s part of what everyone knows, it’s also completely false.

Why don’t people get this? Part of the answer is that it’s really hard for non-economists — and many economists, too! — to wrap their minds around the Alice-through-the-looking-glass nature of economics when you’re in a liquidity trap. Even if they’ve heard of the paradox of thrift, they don’t get the extent to which we’re living in a world where more savings — including savings supplied to your economy from outside — are a bad thing.

Also, and I think harder to forgive, is the way many commentators seem oblivious to how we got here. Yes, we have large budget deficits — but those deficits have arisen mainly as the flip side of a collapse in private spending and borrowing. Here’s what net borrowing by the US private and public sectors looks like in the Fed’s flow of funds report:

Federal Reserve Board of Governors

The US private sector has gone from being a huge net borrower to being a net lender; meanwhile, government borrowing has surged, but not enough to offset the private plunge. As a nation, our dependence on foreign loans is way down; the surging deficit is, in effect, being domestically financed.

The bottom line in all this is that we don’t need the Chinese to keep interest rates down. If they decide to pull back, what they’re basically doing is selling dollars and buying other currencies — and that’s actually an expansionary policy for the United States, just as selling shekels and buying other currencies was an expansionary policy for Israel (it doesn’t matter who does it!).

As Dean nicely puts it, “China has an unloaded water pistol pointed at our heads.” Actually, it’s even better: China can, if it chooses, throw some cold water on us — but it’s a hot day, and we would actually enjoy it.